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Fraser Institute

Powerful players count on corruption of ideal carbon tax

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From the Fraser Institute

By Kenneth P. Green

Prime Minister Trudeau recently whipped out the big guns of rhetoric and said the premiers of Alberta, Nova Scotia, New Brunswick, Newfoundland and Labrador, Ontario, Prince Edward Island and Saskatchewan are “misleading” Canadians and “not telling the truth” about the carbon tax. Also recently, a group of economists circulated a one-sided open letter extolling the virtues of carbon pricing.

Not to be left out, a few of us at the Fraser Institute recently debated whether the carbon tax should or could be reformed. Ross McKitrick and Elmira Aliakbari argued that while the existing carbon tax regime is badly marred by numerous greenhouse gas (GHG) regulations and mandates, is incompletely revenue-neutral, lacks uniformity across the economy and society, is set at an arbitrary price and so on, it remains repairable. “Of all the options,” they write, “it is widely acknowledged that a carbon tax allows the most flexibility and cost-effectiveness in the pursuit of society’s climate goals. The federal government has an opportunity to fix the shortcomings of its carbon tax plan and mitigate some of its associated economic costs.”

I argued, by contrast, that due to various incentives, Canada’s relevant decision-makers (politicians, regulators and big business) would all resist any reforms to the carbon tax that might bring it into the “ideal form” taught in schools of economics. To these groups, corruption of the “ideal carbon tax” is not a bug, it’s a feature.

Thus, governments face the constant allure of diverting tax revenues to favour one constituency over another. In the case of the carbon tax, Quebec is the big winner here. Atlantic Canada was also recently won by having its home heating oil exempted from carbon pricing (while out in the frosty plains, those using natural gas heating will feel the tax’s pinch).

Regulators, well, they live or die by the maintenance and growth of regulation. And when it comes to climate change, as McKitrick recently observed in a separate commentary, we’re not talking about only a few regulations. Canada has “clean fuel regulations, the oil-and-gas-sector emissions cap, the electricity sector coal phase-out, strict energy efficiency rules for new and existing buildings, new performance mandates for natural gas-fired generation plants, the regulatory blockade against liquified natural gas export facilities” and many more. All of these, he noted, are “boulders” blocking the implementation of an ideal carbon tax.

Finally, big business (such as Stellantis-LG, Volkswagen, Ford, Northvolt and others), which have been the recipients of subsidies for GHG-reducing activities, don’t want to see the driver of those subsidies (GHG regulations) repealed. And that’s only in the electric vehicle space. Governments also heavily subsidize wind and solar power businesses who get a 30 per cent investment tax credit though 2034. They also don’t want to see the underlying regulatory structures that justify the tax credit go away.

Clearly, all governments that tax GHG emissions divert some or all of the revenues raised into their general budgets, and none have removed regulations (or even reduced the rate of regulation) after implementing carbon-pricing. Yet many economists cling to the idea that carbon taxes are either fine as they are or can be reformed with modest tweaks. This is the great carbon-pricing will o’ the wisp, leading Canadian climate policy into a perilous swamp.

Business

Broken ‘equalization’ program bad for all provinces

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From the Fraser Institute

By Alex Whalen  and Tegan Hill

Back in the summer at a meeting in Halifax, several provincial premiers discussed a lawsuit meant to force the federal government to make changes to Canada’s equalization program. The suit—filed by Newfoundland and Labrador and backed by British Columbia, Saskatchewan and Alberta—effectively argues that the current formula isn’t fair. But while the question of “fairness” can be subjective, its clear the equalization program is broken.

In theory, the program equalizes the ability of provinces to deliver reasonably comparable services at a reasonably comparable level of taxation. Any province’s ability to pay is based on its “fiscal capacity”—that is, its ability to raise revenue.

This year, equalization payments will total a projected $25.3 billion with all provinces except B.C., Alberta and Saskatchewan to receive some money. Whether due to higher incomes, higher employment or other factors, these three provinces have a greater ability to collect government revenue so they will not receive equalization.

However, contrary to the intent of the program, as recently as 2021, equalization program costs increased despite a decline in the fiscal capacity of oil-producing provinces such as Alberta, Saskatchewan, and Newfoundland and Labrador. In other words, the fiscal capacity gap among provinces was shrinking, yet recipient provinces still received a larger equalization payment.

Why? Because a “fixed-growth rule,” introduced by the Harper government in 2009, ensures that payments grow roughly in line with the economy—even if the gap between richer and poorer provinces shrinks. The result? Total equalization payments (before adjusting for inflation) increased by 19 per cent between 2015/16 and 2020/21 despite the gap in fiscal capacities between provinces shrinking during this time.

Moreover, the structure of the equalization program is also causing problems, even for recipient provinces, because it generates strong disincentives to natural resource development and the resulting economic growth because the program “claws back” equalization dollars when provinces raise revenue from natural resource development. Despite some changes to reduce this problem, one study estimated that a recipient province wishing to increase its natural resource revenues by a modest 10 per cent could face up to a 97 per cent claw back in equalization payments.

Put simply, provinces that generally do not receive equalization such as Alberta, B.C. and Saskatchewan have been punished for developing their resources, whereas recipient provinces such as Quebec and in the Maritimes have been rewarded for not developing theirs.

Finally, the current program design also encourages recipient provinces to maintain high personal and business income tax rates. While higher tax rates can reduce the incentive to work, invest and be productive, they also raise the national standard average tax rate, which is used in the equalization allocation formula. Therefore, provinces are incentivized to maintain high and economically damaging tax rates to maximize equalization payments.

Unless premiers push for reforms that will improve economic incentives and contain program costs, all provinces—recipient and non-recipient—will suffer the consequences.

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Alberta

Alberta’s fiscal update projects budget surplus, but fiscal fortunes could quickly turn

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From the Fraser Institute

By Tegan Hill

According to the recent mid-year update tabled Thursday, the Smith government projects a $4.6 billion surplus in 2024/25, up from the $2.9 billion surplus projected just a few months ago. Despite the good news, Premier Smith must reduce spending to avoid budget deficits.

The fiscal update projects resource revenue of $20.3 billion in 2024/25. Today’s relatively high—but very volatile—resource revenue (including oil and gas royalties) is helping finance today’s spending and maintain a balanced budget. But it will not last forever.

For perspective, in just the last decade the Alberta government’s annual resource revenue has been as low as $2.8 billion (2015/16) and as high as $25.2 billion (2022/23).

And while the resource revenue rollercoaster is currently in Alberta’s favor, Finance Minister Nate Horner acknowledges that “risks are on the rise” as oil prices have dropped considerably and forecasters are projecting downward pressure on prices—all of which impacts resource revenue.

In fact, the government’s own estimates show a $1 change in oil prices results in an estimated $630 million revenue swing. So while the Smith government plans to maintain a surplus in 2024/25, a small change in oil prices could quickly plunge Alberta back into deficit. Premier Smith has warned that her government may fall into a budget deficit this fiscal year.

This should come as no surprise. Alberta’s been on the resource revenue rollercoaster for decades. Successive governments have increased spending during the good times of high resource revenue, but failed to rein in spending when resource revenues fell.

Previous research has shown that, in Alberta, a $1 increase in resource revenue is associated with an estimated 56-cent increase in program spending the following fiscal year (on a per-person, inflation-adjusted basis). However, a decline in resource revenue is not similarly associated with a reduction in program spending. This pattern has led to historically high levels of government spending—and budget deficits—even in more recent years.

Consider this: If this fiscal year the Smith government received an average level of resource revenue (based on levels over the last 10 years), it would receive approximately $13,000 per Albertan. Yet the government plans to spend nearly $15,000 per Albertan this fiscal year (after adjusting for inflation). That’s a huge gap of roughly $2,000—and it means the government is continuing to take big risks with the provincial budget.

Of course, if the government falls back into deficit there are implications for everyday Albertans.

When the government runs a deficit, it accumulates debt, which Albertans must pay to service. In 2024/25, the government’s debt interest payments will cost each Albertan nearly $650. That’s largely because, despite running surpluses over the last few years, Albertans are still paying for debt accumulated during the most recent string of deficits from 2008/09 to 2020/21 (excluding 2014/15), which only ended when the government enjoyed an unexpected windfall in resource revenue in 2021/22.

According to Thursday’s mid-year fiscal update, Alberta’s finances continue to be at risk. To avoid deficits, the Smith government should meaningfully reduce spending so that it’s aligned with more reliable, stable levels of revenue.

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